"The provision of the Constitution giving the war making power to Congress was dictated . . . by the following reasons: kings had always been involving and impoverishing their people in wars, pretending generally, if not always, that the good of the people was the object. This our convention understood to be the most oppressive of all kingly oppressions, and they resolved to so frame the Constitution that no one man should hold the power of bringing this oppression upon us." -- Abraham Lincoln

The Commons is a weblog for concerned citizens of southeast Iowa and their friends around the world. It was created to encourage grassroots networking and to share information and ideas which have either been suppressed or drowned out in the mainstream media.

"But if the cause be not good, the king himself hath a heavy reckoning to make, when all those legs and arms and heads, chopped off in battle, shall join together at the latter day and cry all 'We died at such a place;' some swearing, some crying for a surgeon, some upon their wives left poor behind them, some upon the debts they owe, some upon their children rawly left. I am afeard there are few die well that die in a battle; for how can they charitably dispose of any thing, when blood is their argument? Now, if these men do not die well, it will be a black matter for the king that led them to it; whom to disobey were against all proportion of subjection." (Henry V, Act V, Scene 4)

Friday, October 20, 2006

Paul Krugman - Incentives for the Dead

Incentives for the Dead

By PAUL KRUGMAN

I don’t know about you, but I need a break from political scandals. So let’s talk about private-sector scandals instead — specifically, the growing scandal involving backdated stock options, which this week led to the resignation of William McGuire, the chief executive of UnitedHealth Group.

To understand the issue, we need to go back to the original ideological justification for giant executive paychecks.

In the 1960’s and 1970’s, C.E.O.’s of the largest firms were paid, on average, about 40 times as much as the average worker. But executives wanted more — and professors at business schools provided a theory that justified much higher pay.

They argued that a chief executive who expects to receive the same salary if his company is highly profitable that he will receive if it just muddles along won’t be willing to take risks and make hard decisions. “Corporate America,” declared an influential 1990 article by Michael Jensen of the Harvard Business School and Kevin Murphy of the University of Southern California, “pays its most important leaders like bureaucrats. Is it any wonder then that so many C.E.O.’s act like bureaucrats?”

The claim, then, was that executives had to be given more of a stake in their companies’ success. And so corporate boards began giving C.E.O.’s lots of stock options — the right to purchase a share of the company’s stocks at a fixed price, usually the market price on the day the option was issued. If the stock went up, these options would pay off; if the stock went down, they would lose their value. And so, the theory went, executives would have the incentive to do whatever it took to push the stock price up.

In the 1990’s, executive stock options proliferated — and executive pay soared, rising to 367 times the average worker’s pay by the early years of this decade.

But the truth was that in many — perhaps most — cases, executive pay still had little to do with performance. For one thing, the great bull market of the 1990’s meant that even companies that didn’t do especially well saw their stock prices rise.

Then there were the tricks that companies used to ensure lavish executive pay even if the stock simply seesawed up and down. For example, after a downward move in the stock price, executive stock options would often be repriced or swapped — that is, the price at which the executive had the right to buy stocks would be reduced to the new market price. Heads the C.E.O. wins, tails he gets another chance to flip the coin.

What the backdating scandal reveals is that for many executives even that wasn’t enough. To ensure that executives profited from newly issued options, companies would pretend that the options had in fact been issued at an earlier date, when the stock price was lower. Thus a contract that Mr. McGuire signed in December 1999 included a grant of one million stock options dated back to Oct. 13, the day UnitedHealth’s stock price reached its low point for the year.

What’s wrong with backdating stock options? There’s a tax evasion aspect, but the main point is the bait-and-switch. The public was told that gigantic executive paychecks were rewards for exceptional performance, but in practice executives were lavishly paid simply for showing up at the office.

And in some cases even that wasn’t required. Cablevision Systems gave options to a deceased executive (in other words, to his heirs), backdating them to make it appear that he had received them while still alive.

The moral of the story is that we still haven’t come to grips with the epidemic of corporate misgovernance revealed four years ago by the Enron and WorldCom scandals, then drowned out as a political issue by the clamor for war with Iraq. Even now, we’re still learning how deep the rot went.

And there’s no reason to believe that the problem has been solved. Three years ago, Warren Buffett declared that reining in runaway executive pay was the “acid test of corporate reform.” Well, executive compensation, which fell briefly after the Enron and WorldCom scandals, has shot right back up.

So we’re still waiting for serious corporate reform. And don’t tell me that everything must be O.K. because stocks have been rising lately. Remember, they rose even faster in the 1990’s — and the 1920’s.